MacroSim2 is simply the MacroSim1 model with a financial sector added. Generally, a mathematical version of the Loanable Funds model has been added to the equation set. This addition of a financial sector will have a tremendous effect upon the simulations that result from policy change assumptions, especially those that involve the budget deficit. The reader here is assumed to fully understand the Loanable Funds model and how it works.
In MacroSim2 the level of investment is no longer autonomous. Instead, it is responsive to the interest rate. Savings is no longer a residual variable as it was in MacroSim1. It is also sensitive to the interest rate. Finally, this model has a money supply that can be controlled as a policy variable and which, in turn, can affect the interest rate.
As can be seen in the mathematical structure of MacroSim2 below, the primary aggregate demand variables from MacroSim1 are reproduced without modification, in equations 1 though 4. The equations below that, 5 through 8, represent the addition of the Loanable Funds model.
TABLE 1: MATHEMATICAL
STRUCTURE OF MACROSIM2
|
(1) |
Y = C + I + Go |
Gross Domestic Product (Y) equals Consumption (C), Investment (I), plus Government Spending (G), G is autonomous (but not I), determined by the user. |
|
(2) |
C = a + b(YD) |
Consumption is determined by Disposable Income (YD) where “a” is autonomous consumption and “b” is the consumption rate from disposable income.
|
|
(3) |
YD = (1 – t)Y |
Disposable Income is after-tax income and “t” is the income tax rate. |
|
(4) |
D = Go - tY |
The Budget Deficit (D) is equal to Government S pending less tax collections. |
|
(5) |
DMS = (MSGRo)*MS |
The change in the Money Supply (DMS) is equal to the Money Supply Growth Rate (MSGRo), an autonomous variable, times the Money Supply (MS). |
|
(6) |
I = h + dR |
Investment (I) is now a linear function of the interest rate (R), where “d,” which is always assumed to be negative, measures the sensitivity of investment to the interest rate, and “h” is “autonomous investment.” |
|
(7a) |
S = e + k +fR |
Savings (S) is now a linear function of the interest rate (R), where “f,” which is always assumed to be positive, measures the sensitivity of savings to the interest rate. “e” represents autonomous savings and “k” represents past contributions to savings due to increases in the money supply in the past (see equation 7b). |
|
(7b) |
k = MS(t) – MS(0) |
In multiple simulations (of a growing economy, for example), “k” represents the increase in the Money Supply from its initial value to its value in the current simulation. |
|
(7c) |
S = YD - C |
As in MS1 equation 5a, the identity that savings will equal Disposable Income minus consumption must hold. |
|
(8) |
S + DMS = I + D |
This is the Loanable Funds model equilibrium condition: the Supply of Funds, Savings plus the change in the Money Supply, must equal the Demand for Funds, Investment plus the Budget Deficit. |
Equation (8), the Loanable Funds model equilibrium identity, assumes that all of the supply of credit (the supply of funds) is explained by new savings and an increase in the money supply, a policy variable that is controlled by the nation’s central banking authority. It also assumes that all investment and all of the government’s budget deficit is financed by borrowed money. This model assumes no consumer borrowing (it would complicate the model without adding any insights) and assumes no foreign sector.
MACROSIM2 HOMEWORK
At this point, start the MacroSim model and bring up the MacroSim2 homework, and complete that homework assignment (which may consist of two parts). Because that is an older pdf file that cannot be altered, this model is again presented at the introduction of that homework set.